What’s a 529?

Does anyone else feel like their social media timelines have been filled with pregnancy and birth announcements?

At the beginning of quarantine, there was a prediction of a forthcoming baby boom and they were not wrong. While I cannot confirm the scale of this COVID baby boom compared to the Baby Boomer generation, I can tell you that the past few client meetings have been filled with baby announcements that quickly turn into college savings conversations.

When it comes to college savings and the conversations generated around this topic, there are three numbers that reign supreme 529.

The Name

The name “529” comes from section 529 of the Internal Revenue Code that was added in 1996 that allowed for individuals to create college savings plan. College savings plans have a distinct section within the IRC because they have distinct features that make it one of the most tax efficient ways to save and invest.

Tax Characteristics

So what makes a 529 College Savings Plan so unique? Let’s count the ways.

  1. Contributions made to the account qualify for a state income tax deduction (in some states). 
  2. Contributions grow tax-free while invested within the 529 account.
  3. Contributions are tax-free at distribution when used for qualified educational expenses.

In the world of personal finance and investing, we call this type of account the triple threat given the tax savings at contribution (in some states), during the lifetime of the account and at distribution. There are very few accounts in the personal finance toolbelt that offer this type of preferential tax treatment. 

Contrast the 529 with saving for college in a taxable investment account. Even without the state income tax deduction, each year the income and dividends produced by the account are taxed as income. And don’t forget about the capital gains tax assessed at distribution when positions are sold to cover college tuition. The combination of those two elements alone leave less purchasing power when compared to letting those dollars grow within the tax efficient 529 environment.

Other Benefits

If the tax savings alone aren’t enough to peak your interest, let’s talk about some of the other benefits that come with a 529 college savings plan. Already referenced, but worth mentioning twice, dollars within a 529 can be invested and grow with the market. Much like 401(k)’s benefit from a long-term investment strategy, so can funds earmarked for a child’s education.

A second and third added benefit from a estate planning perspective is that the funds within a 529 are owned and directed by the account holder but are for the beneficiary of the minor with their sights set on college. In other words, that future college student does not have control of the assets and cannot decided to buy a sports car with those dollars instead of a college education. The account holder has total control. While that account holder has total control, the 529 is not included in their taxable estate. This is another wonderful benefit of the 529 account, especially those with a potential taxable estate issue, perhaps grandma and grandpa?

The final benefit of a 529 is their flexibility, specifically the beneficiary flexibility. As mentioned, each 529 account has an account holder and beneficiary. Over the life of the 529 account, the beneficiary can be amended and renamed, as needed. A common example is renaming the beneficiary from big sister to little brother after big sister graduated from college with funds leftover in the account. The dollars remaining can be reallocated to little brother to help fund his college expenses.

The Strategy

Has this piece convinced you to open and start funding a 529 account for your future scholar yet? If so, a great place to start is by having a conversation with a financial advisor to determine a target savings plan to help your child with college expenses. There is no one size fits all savings strategy and it can be customized to cover two years of tuition all the way up to graduate school.

Independent on the parameters of the college funding goal and the number of accounts set-up, the first step in the process is to set-up the account and investment allocation and begin funding. Some numbers to keep in mind is the threshold for making a taxable gift of $15,000 per donor to donee and the maximum state income deduction amount, if applicable for your state. 

Once those values have been identified and accounted for, it’s recommended to set-up automatic monthly contribution to meet the target savings amount. Treat these contributions like the deferrals into an employer 401(k) and set-it and forget it.

There is not right time to have this discussion, the most important thing is that it’s a conversation that happens. Looking for someone to have this conversation, be sure to reach out to a qualified financial advisor before those babies become a “quaranteen”!

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